Ratings Game: 2 Picks in TV Station Stocks

TV station stocks, valued by the market as if they will be dead in eight years or less, are, we believe, much better than that. We expect to see persuasive proof in coming months.

We are initiating coverage of sector leaders Sinclair Broadcast Group (ticker: SBGI) and Nexstar Media Group (NXST) at Buy and adding Sinclair to the Alpha Generator list. We give Sinclair a $43 price target, for a potential return of 37% from the Oct. 26 close, and Nextstar a $79 price target, for upside potential of 24%. We maintain our Neutral rating and $15 price target on Tegna (TGNA).

Valuations absurdly miss the mark on this appealing sector. Pro forma for the transformative, over 40% free cash flow accretive Tribune merger, Sinclair trades near four times free cash flow. Nextstar is near five times. We see both valuations as an absurd overreaction to secular pressures for a sector that is relatively better positioned for internet threats than TV networks. TV station companies also have additional upside potential from NextGen TV technology, loosening regulation, and tax reform.

Local news is the place to be. The main value driver for TV stations is local news; subscription video on demand (SVOD)/internet players either do not offer or have largely failed at local news, while the main remaining rivals -- newspapers -- are weakening and video-starved. Local news audiences are stable, a stark contrast to other parts of TV, and stations are hedged to cord cutting, as they dominate skinny bundles and can be viewed via rabbit ears. We expect stations to garner more respect from investors after Sinclair successfully renews tough 21st Century Fox (FOX) carriage talks.

At its Nov. 16 meeting, the Federal Communications Commission is poised to approve the start of a multiyear voluntary transition to a more advanced Internet Protocol-based ATSC 3.0 broadcast standard that supports new interactive applications. One benefit is more efficient encoding, which could free up four-fifths of current TV spectrum for new uses. In our proprietary analysis, we estimate that over several years this freed-up spectrum could be used to drive a 20%-40% increment to current equity value for Nexstar, Tegna and Sinclair.

After a brutal 2016, when President Donald Trump won largely without advertising on TV, political advertising looks strong for 2018. Our proprietary analysis shows a 33% rise in competitive House and gubernatorial races in 2018, with Sinclair best exposed.

Loosening the prohibition on top four station mergers could also boost sector value. Also at the Nov. 16 meeting, the FCC is poised to approve new ownership rules that enable the FCC, on a case-by-case basis, to approve mergers of top four stations. Our proprietary analysis suggests the potential for this to drive a 3% to 10% increment to earnings before interest, taxes, depreciation and amortization (Ebitda) at Nexstar, Sinclair and Tegna.

We model a modicum of noise in the third quarter around Hurricane Harvey for Sinclair and see merger muddiness making the 2018 consensus too high for Nextstar. But, at these valuations, these are more “beat the grim reaper” stories than “beat and raise.” There is also the potential for estimate step-ups from tax reform (where TV stations are well exposed) and a tax cut--fueled step-up in economic growth, which could help TV advertising.

We value both Sinclair and Nextstar in one year at 8.5 times average estimated 2018 and 2019 Ebitda, with average free-cash-flow yields in the midteens--discounts to TV network peers. Arguably, station groups could fetch premiums because of better secular positioning and optionality on ATSC 3.0 [standard].

-- Barton Crockett -- Zack Silver

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